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  1. Home
  2. / Investing
  3. / Technology

Why the Cryptocurrency Selloff Might Still Have Further to Go

There are still reasons to be optimistic about the long-term adoption of Bitcoin, Ethereum and certain other cryptos. But the selloff following a leverage-fueled speculative mania like the one we just saw rarely ends quickly.
By ERIC JHONSA
May 19, 2021 | 04:01 PM EDT
Stocks quotes in this article: SHOP, ROKU, ZS

In several ways, the cryptocurrency crash seen over the last week or so brings to mind the plunge seen in a host of very richly-valued tech stocks in late February and early March, only on a more compressed timetable.

And if the unwinding of the speculative frenzy in those tech stocks is any guide, this morning's lows won't spell the bottom for most cryptos, many of which are still trading far above their February and March levels.

Just as the speculative mania seen in parts of the stock market was fueled in part by enthusiasm about products, services and technologies that had undoubtedly made big strides in terms of both capabilities and user adoption -- think electric cars, e-commerce, streaming, cloud software, etc. -- the crypto boom was driven in part by enthusiasm for things such as growing retail and institutional support for Bitcoin as a store of value, and Ethereum's ability to underpin a broad ecosystem of DeFi apps and services.

However, just as the big run-ups in quality (if richly-valued) growth tech names such as Shopify (SHOP) , Roku (ROKU) and Zscaler (ZS)  were eventually accompanied by both the GameStop/WallStreetBets phenomenon and manic speculation in a host of low-quality SPACs and small-caps, the crypto mania eventually spread beyond Bitcoin and Ethereum -- and for that matter, legitimate altcoin-based crypto projects such as Chainlink and Uniswap -- to include memecoins such as Dogecoin and Shiba Inu Coin, as well as a host of other tokens that are either of dubious utility or don't appear to be used nearly enough in real-world applications to justify the big market caps they've been granted.

In each case, having a bubble expand to feature many lower-quality assets not only undermined its credibility, but also created a supply/demand problem, as the funds of speculators wound up being spread out over a larger number of targets.

Also like the bubble seen in parts of tech, leveraged bets both played an important role in fueling the crypto mania on the way up and now look poised to worsen declines on the way down. A number of crypto exchanges have supported 10x margin leverage and 50x or greater futures leverage -- Binance supports up to 125x and 100x leverage on Bitcoin and Ethereum futures contracts, respectively, and up to 50x or 75x leverage for a slew of other cryptos. It's not hard to guess what happens to crypto prices when such contracts are liquidated en masse due to maintenance requirements not being met.

For all these reasons, I made a handful of moderately-sized, crypto-related short bets over the last couple of weeks, as Ethereum, Dogecoin and others first saw blow-off rallies and then began seeing momentum waver. And with the total value of all cryptocurrencies still up 115% year-to-date and more than 530% over the last 12 months as of the time of this article (source: CoinMarketCap), I think this selloff has farther to go, even if we're likely to see some additional sharp rallies along the way.

Just as being negative on the valuations given to many cloud software and e-commerce names at their February highs doesn't necessarily make one bearish on the companies' growth prospects -- or unwilling to buy them at more moderate valuations -- I think there are still reasons to be optimistic long-term about greater adoption of Bitcoin as a store of value and potential inflation hedge. And that's also true of DeFi lending, asset-trading and data-sharing services made possible by Ethereum and various projects running on top of it to see large-scale usage.

The concept of being able to leverage smart contracts to provide or access financial services without the need for an institutional intermediary is a powerful one, even if much work still needs to be done to fully make good on its long-term promise. Even NFTs, for all the speculative excess they've been party to lately, could have some staying power, judging by how digital artists, gamers and others have begun using them to monetize their work.

As a result, when this crypto selloff has run its course and many recent speculators have been driven out, I think there could be long-term buying opportunities in Bitcoin, Ethereum and some of the more credible altcoins, in much the same way that Bitcoin's 2014 and 2018 crashes created opportunities for patient buyers.

But at a time when Dogecoin still sports a $45 billion-plus market cap and more than two dozen cryptos sport $5 billion-plus market caps, it's probably best to tread carefully in the short-term.

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At the time of publication, Eric Jhonsa was short Dogecoin and the Grayscale Ethereum Trust.

TAGS: Investing | Technology

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